(Below is an article about last minute planning considerations in light of the new tax act written by my colleague Andreea Olteanu, JD of WealthCounsel.)
With 2017 coming to an end and sweeping tax reform legislation (Act) having been signed into law, some last-minute opportunities should be considered while the current law still applies. There are steps that taxpayers can take before the Act takes effect in January that could lower their tax bills for the 2018 tax season. Following are several suggestions on how to implement these strategies before the window of opportunity closes at the end of December.
Increase and Accelerate Deductions
Arguably, one of the most controversial provisions in the Act is the limitation on the deduction for state and local taxes (SALT). Under the Act, individuals cannot deduct more than $10,000 of combined property, income, and sales taxes. The obvious reaction would be to maximize the SALT deduction under current law by pre-paying now as much of next year’s taxes as is currently allowable. Anticipating that taxpayers may take advantage of this loophole, the Act provides that any amount paid in a taxable year beginning before January 1, 2018, for income taxes imposed for a taxable year beginning after December 31, 2017, are treated as having been paid on the last day of the taxable year for which the tax is imposed.
However, some taxpayers may have outstanding income tax bills for 2017, which should be paid before the end of the year and can be deducted for this year’s taxes.
Additional estimated payments that might otherwise be due in April 2018 for 2017 state taxes could also be paid before the end of the year.
There is no such corresponding restriction applicable to pre-payment of property taxes. So, for example, winter property tax bills that would normally be paid in 2018, could be paid before the end of 2017.
Mortgage interest remains deductible under the Act, whereas interest on home equity loans would not be. Clients should consider paying off as much of their home equity loans as is practical while the deduction is still available under current law. In both instances, an early monthly payment that would otherwise be due in January could be made in December to increase the deductions available for the 2017 return.
Employees should pay as many unreimbursed expenses as possible before the end of December, since these deductions will disappear in January. The same applies for work-related moving expenses, which will no longer be deductible under the Act.
The deduction for professional fees, such as attorney and accountants’ fees, is also disappearing under the new law. Taxpayers should see if their advisors will accept early payment for anticipated services, so that the deduction can be taken in 2017 while it is still available.
Giving to charity is tricky. Although the charitable deduction remains in place under the Act, the lower income tax rates next year may make a charitable deduction more valuable for 2017 than for 2018. Clients may also consider setting up donor advised funds before the end of the year, which will allow them to maximize the charitable deduction, while preserving the right to determine how to donate the funds at a later time. Other charitable giving strategies, such as charitable remainder trusts, could also be considered, but setting up a trust may require more time than is available before the end of the year.
Although the foregoing are viable strategies that would maximize deductions for 2017 that are either limited or unavailable as of next year, they generally only make sense if a taxpayer itemizes deductions. While it is more likely that a taxpayer will itemize for 2017 when the standard deduction is relatively low, the much higher standard deduction as of 2018 (from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples, both indexed for inflation), will make itemizing less likely. So, things like the charitable, mortgage, and the limited SALT deductions, even though they will still be available next year, are less likely to be utilized in 2018 than in 2017. However, for taxpayers who still plan on itemizing next year, an analysis should be done to determine in which year the deductions that are still available under the Act and can be paid in either year will be most beneficial.
Businesses, also, should consider accelerating expenses for 2017, since they might prove more useful to offset the higher income tax rates under current law. However, a careful analysis must be made to see how the figures work out, because next year will allow for the immediate expensing of capital investments, as well as more beneficial depreciation.
While accelerating deductions before the end of the year is probably a good strategy for most taxpayers, the reverse is true for income. Considering the 2018 reduction in income tax rates, most taxpayers, individual and businesses alike, will likely benefit from deferring income until next year. This technique has generally already been implemented by those wishing to defer the payment of taxes on a portion of their income for another year. However, this might prove particularly beneficial in this end-of-year planning phase for those taxpayers expecting to see a drop in their tax rates next year.
Deferring income, however, may not make sense for families with three or more children. Personal exemptions have been eliminated as of 2018. So, families with three or more children will theoretically pay less in taxes on income earned in 2017 by utilizing the high number of personal exemptions available under current law, than with the increased standard deduction in 2018.
Although not an income deferral strategy, per se, taxpayers should also look closely at their IRAs before year-end. Roth recharacterization, which essentially provides taxpayers with the opportunity to undo a Roth conversion, will no longer be available as of 2018. Any conversion from a traditional IRA to a Roth IRA that is being considered before year-end should be scrutinized more carefully than before, as it cannot be undone under the new law.
The general rule of thumb is to increase and accelerate deductions, and to defer income. Since the tax rates are dropping as of next year, a deduction in 2017 to offset the higher current rates is more valuable than it will be next year. In addition, most itemized deductions have been eliminated, while others have been limited. Income should be deferred and taxed under the lower rates effective as of next year.
Although these are general principles, each taxpayer’s situation should be assessed to determine the most beneficial approach. There is very little time left to take advantage of these strategies. And especially now, during the holiday season, taxpayers want to spend time with their families, not worrying about taxes. But the effort of spending a few hours this week with your tax advisor could result in a significant savings on your tax bill next year.